Twelve Laws of the
Business Buying

Russell L. Brown

I've
worked with many business sellers and many more potential
business buyers over the years and let me tell you; it's never
easy getting a deal accomplished! I strongly believe and firmly
advocate that the absolutely best way for an entrepreneur to
successfully get into business, or expand what they already
have, is buy an existing profitable company. But there are many
obstacles and pitfalls along the way that must be overcome. It
really is a jungle out there!

To help those who are
considering buying or selling a business, I offer the following
overview of what I think are the twelve most important Laws of
the Business Buying and Selling Jungle. These have been
excerpted in part from my book, Strategies for Successfully
Buying or Selling a Business, in which each Law is examined and
discussed in much greater detail.

Jungle Law #1: Lawyers Are
Deal Killers!

There certainly is an
important role for a competent commercial law attorney to advise
and prepare the legal structure of a business purchase and sale
transaction. The problems arise when lawyers see themselves as
business negotiators whose mission is to get the "best deal" for
their clients. They frequently forget that the "best deal" has
to involve both parties, the buyer and the seller, and that
compromise is usually the best solution. Lawyers generally have
a very difficult time with compromise in this type of situation
because they often see their role as advising their clients on
how to get the better deal. Usually, an attempt at a lopsided
deal for either party will result in "no deal" at all.

As a matter of basic
principle (and law in most States), all business brokers dealing
with the public are bound to be honest and forthright in their
conduct concerning the businesses that they represent for sale.
But they also have a fiduciary relationship (position of trust)
to uphold between themselves and their clients (the business
seller, in most cases). They must present a business for sale in
its "best light" without misrepresenting any significant facts
but at the same time not pointing out all of the potential
business pitfalls. This usually establishes an adversarial
relationship between the buyer and the broker as well as between
the buyer and the seller. The best course of action for a buyer
is to trust only what they can verify during a rigorous due
diligence process and the best approach on the part of the
seller/broker is full disclosure of all pertinent information.

Jungle Law #3: A Business
Is Worth Only Whatever Someone Is Willing To Pay For It At A
Particular Point In Time!

Buyers and sellers are
natural adversaries; the sellers want as much as they can get
and the buyer wants to pay as little as possible. The broker is
intensely interested too, because the commission amount is
usually based on a percentage of the total selling price. So,
what process should you use to value a business? Forget about
putting a value on the assets based on resale value. Forget
about comparing the business to the one in the next town that
sold for a particular amount. Forget about all the "rules of
thumb" like X times earnings or Y times gross income or some
dollar amount per account or any other shortcut formula. A
business value, and therefore its selling price, only makes
sense when it's based on the capitalized earnings stream.
Capitalization is simply the process used to determine today's
value of a stream of future earnings. In the case of valuing a
business, "today's value" is the value of the business, and the
"stream of future earnings" is the expected future years' profit
of the business based on current earnings. Most small businesses
sell for a price in the range of 2-5 times earnings before
interest and tax expenses are deducted.

Jungle Law #4: A Business
Buyer Is Really Buying A Stream Of Earnings!

The assets of the business
are just the tools of the trade that enable an earnings stream
to be realized. Without the earnings stream, the business
essentially has no value. You should note that in using this
method, a business may actually be worth less than its fair
market asset value or in many cases worth substantially more. A
seller will be able to get the most they can for a business by
showing a buyer the true investment value in the business based
on provable earnings.

Jungle Law #5: Ignore All
Claims Of Unreported Income!

This is a very sensitive
subject known as unreported (to the IRS) cash sales. Some
business sellers may try to get you to accept their claim that
they had significant amounts of cash income that did not show up
on their IRS Tax Return and accordingly want you to include this
phantom income in your valuation of their business. I highly
recommend that you totally ignore these claims and deal only
with the business's reported income. Who is to say if the
business owner's claims are true? If the business owner will lie
to Uncle Sam might they not also lie to you?

Jungle Law #6: Most
Sellers Are Fibbers! (Or They At Least Stretch The Truth)

Of course, this is not a
completely true law of the jungle. Most sellers are honest
people trying to get by in life like everyone else. However, a
buyer should approach all information provided in the sale with
some skepticism. Buyers are making a major financial decision
and should carefully consider all information presented during a
detailed due diligence process. If a buyer approaches the
purchase of a business with a good healthy dose of "prove it to
me," then it will be difficult for them to get burned.

Jungle Law #7: If A Seller
Really Wants To Sell, You Probably Shouldn't Buy!

Whenever you look at any
business for sale, you should approach the situation with a
great deal of caution. You should make it your business to
verify all of the facts possible about the business, including
determining the reason for sale. There are some very good
motivations for sellers to sell and other ones that are not so
good. Usually, the best reason for a sale from the buyer's
perspective is the planned retirement of the owner or a sale
necessitated by illness. By far, the best potential purchase is
a long-standing single-owner profitable business where the owner
is approaching (or at) retirement age and is generally reluctant
to sell but realizes that he eventually has to.

Jungle Law #8: 99% Of
Potential Business Buyers Never Buy A Business!

This alone may be reason
enough for a seller to retain a business broker to represent him
in selling the business. A professional broker knows how to sort
through the many non-qualified potential buyers to get to the
few who actually do have the means and motivation to buy a
business. Once the unqualified potential buyers have been culled
out, still only somewhere around 50% of these folks eventually
buy a business. For this and many other reasons, I strongly
recommend that sellers use a professional business broker to
represent them in selling their business.

Jungle Law #9: Always
Assume There Are Skeletons In The Closet!

Most businesses have some
negative feature(s) that the seller will be reluctant to talk
about. You can be sure that any problems will come out later as
buyers begin analyzing the business (due diligence), and it
could kill the sale if the problems are perceived as cover-ups.
This is because buyers will ask themselves (logically) "if they
hid this fact from me, what else are they hiding?" If the
negative aspect(s) is clearly presented and discussed with the
buyer, it may not be a serious problem because the buyer may
feel that it can be overcome, avoided, or changed. The seller
should strongly consider this and determine all of the possible
negative factors that could affect the sale of the business. If
the problems are very serious and non-correctable, the business
may not be salable.

Jungle Law #10: Someone
Will Always Get Cold Feet Just Before The Closing!

Closing the deal is always
difficult, but usually the shortest part of buying or selling an
operating business. After all, the valuations, investigations,
and negotiations are complete and now it's a matter of getting
everything into writing in a form that satisfies everyone so
that the transfer of ownership of the business can take place.
However, you can definitely count on someone getting cold feet
just before the closing. Be prepared for this! The seller and
buyer may both start to wonder if they are really getting a fair
deal. The best way to get ready for this is to anticipate it
happening and then to deal logically, reasonably and
unemotionally with it at the time.

Jungle Law #11:
Negotiations Must Stop At The Signing Of The Purchase And Sale
Agreement!

Once the Purchase and Sale
Agreement has been signed by both the seller and buyer, there is
an excellent chance that the sale will actually take place. But,
there must be an end to the negotiation process or things will
begin to unravel. The deal at this point is like a house of
cards with many parts of the negotiated deal contingent on
another part. Trying to reopen negotiations after a Purchase and
Sale Agreement has been signed will most likely lead to a
collapse of the entire deal.

Jungle Law #12: After
Buying A Business, Do Not Change Anything (At First)!

Of course, this doesn't hold
true if you're buying a turnaround situation; but in general, if
the business you are buying is profitable, leave it alone while
you learn how to manage it in accordance with the status quo.
One of the experiences I have had that best illustrates this
point is as follows: One buyer of a fast food chicken franchise
soon after the closing changed meat suppliers because he found
that he could get the chicken at 10˘ a pound cheaper. What the
new owner did not realize was that these chicken pieces were 25%
larger than those provided by the original supplier. The problem
with this is; the franchise doesn't sell chicken by the pound;
it sells it by the piece. The new franchise owner completely
wiped out his profit margin by paying a smaller price per pound
but delivering to the customer 25% more chicken at the same
retail price!